By law, you must keep financial records which are reliable and provide an accurate view of your business. Internal Revenue Code Section 6001 requires businesses to keep records appropriate to their trade or business. The IRS has the right to view these records in the event they want to audit your business’s (or your personal) tax return. If they do not like what they find, the penalties can be deadly to your business and your own personal financial well-being. In addition to the IRS’s ability to audit your books, states often have laws requiring such records and surprise auditors who show up unannounced insisting on seeing your state tax records.
Common sense demands financial records as well. Without financial records you are probably going to lose deductions and have much less control over how much money you make (or lose). For those of you with no accounting experience or training, record keeping may seem like a daunting and burdensome task, but it does not have to be. In this section we will discuss ways to make it simpler and, hopefully, less expensive.
Do it Yourself or Hire Someone Else? Many small business owners hire someone to “keep the books” rather than do this work themselves. Bookkeepers can a certified CPA, a secretary or even someone who works part-time keeping track of financial records. The price for such services should be somewhere between $10 and $40 an hour depending on the level of qualifications and experience. (Clearly, the CPA is going to be the highest priced bookkeeper.)
Always, always, always check into the background of your bookkeeper. You need to do this for two reasons. First, you need to make sure that the know exactly what they are doing. Your bookkeeper must know about payroll deduction, income taxes, state and local taxes, filing deadlines, etc. Second, you must determine that your bookkeeper is so ridiculously honest that you can actually trust that person to watch YOUR money. Giving someone control over your money is a very, very serious matter, as you well know. it is made more serious by the fact that if your bookkeeper does not pay taxes either on time or at all, your business and YOU PERSONALLY will be held liable by the IRS and your state and local tax authorities. There would, of course, be fines and penalties as well as the underlying tax bill.
While we understand that you probably have no desire to engage in routine record keeping and tax work, you might want to consider developing your own record keeping system. Consult a tax professional who can help you develop your record keeping system, preferably a CPA who specializes in helping small businesses in your industry. Once you have the system in place and know how it works, then hire someone to look after it for you and teach them to use your system for your books. Then you are not dependent ion your bookkeeper, if he leaves, you can do your own books until you hire a replacement. Or if your seems untrustworthy or incompetent after you hire them, you can perform your own checks of your records to make sure everything is okay.
Doing it Yourself First of all, buy Quick Books from Intuit. (You are using a computer to look at this so we assume you have a computer already.) Using computer programs to keep track of business affairs is probably the best record keeping advance since the development of the double-entry accounting system, there is no point in not taking advantage of this, right? You will no longer have to worry about sloppy handwriting, computational errors, and data reorganization. We use Quick Books for Tanned Feet, an investment advisory service, a law practice, and a (flagging) music promotion business. For each of these types of service-businesses, Quick Books is more than adequate. If you have inventory Quick Books is more complicated, but it is still far better than keeping records on paper. The biggest payoff to using Quick Books is at tax time. With a few clicks of the mouse, you are nearly done gathering all financial information necessary for tax filings.
Quick Books accounts can be set up in about an hour. You may want to spend an afternoon reading through the manuals and information they send along with the program–it is very helpful. We really cannot emphasize enough how much a computer system will help the neophyte business person organize and maintain their business records, so even if you do not like Quick Books, try another program Such as Peachtree Accounting.
For those of you who insist on keeping your records on paper (Can you tell we are really trying to persuade you not to do this?), the method of organizing your records of expenses and income is fairly simple. You record all money paid to you, paid out to another, owed to you, or owed to another in your business’s “ledger”. Any office supply store will carry a selection of lined paper set out in ledger format. Use this ledger to set up a list of your business expenses as they are incurred (money paid out), another list of money which is paid to you (business revenue).
Good record keeping is essential for any business. From the beginning, there are three types of records your business should absolutely maintain: a record of expenses, a record or income, and a record of assets. We briefly discuss each of these below. We do not delve very deeply into exactly why you need to keep these records, but as you read other sections in the Taxation section of this page, it may become clear. If it does not become clear, no big deal, just believe us when we say that your accounting bills will be far smaller if you keep these records in order.
Receipts and Record of Expenses Like any business, you will incur expenses. Most of these expenses are deductible when tax time comes. All receipts, invoices, canceled checks, contracts requiring payments by you (e.g., leases) involving a pay out of money from your business should be stored in a folder. (Preferably a folder which contains evidence of similar expenses — it is best if you order them by type rather than by date.) Credit card statements should be kept even if you have the underlying receipts from the transaction.
You should jot down a quick note on all canceled checks and copies of receipts reminding you of what the expense involved. For instance, if you take a client out to dinner, write the client’s name on the receipt, why you were having lunch (i.e., what business matter you discussed), the amount of the bill, and the restaurant. Or if you buy office supplies and the receipt does not list the items purchased and their respective cost, write them down yourself.
In addition to such records, you should keep a journal or “record of expenses” recording, at the least, the following information:
- How the expense was paid (credit card, cash, check number)
- Date of the transaction
- The party to whom the money was paid.
- The particular type of expense involved (e.g., office supplies, equipment, utilities, rent, etc.)
Income/Revenue Records Hopefully, like many enterprises, your business will make money as well as spend it. Just like expenses, you need to record all income (revenue) of your business. Your business’s income, or “gross receipts”, needs to be carefully tracked because not all money your business receives will be taxable income. Money you receive from clients in return for your business’s goods or services is taxable income. Money you receive from the bank as a loan is NOT. At the end of the year when you are figuring out your tax bill, it is vitally important for you to be able to separate the two and pay tax only on the former.
Different businesses use different methods of recording their business income. Your local grocery store probably uses electronic cash registers which feed their totals into a central system. A local government one of the authors worked for during college simply deposited its revenues in a bank account and recorded the amounts deposited. You, being the business-savvy entrepreneur of the computer age, will keep track of your income on your accounting program, right? Right?! (Or you could use a manual system. See below. <sigh>)
It is absolutely vital that your records of income received (or other moneys received, such as loans) give you at least some indication of precisely where the money came from and why you received it. You see, if the IRS audits you and it finds that your business’s bank records show deposits totaling $200,000 but your tax return shows reported income of $150,000, a stern IRS auditor is going to ask you how your business came to posses that unreported $50,000. if you cannot say precisely what its was (e.g., money lent by your bank, return of money lent to a relative, money inherited by you and put into your business, etc.), the IRS will label it “unreported income” and you will have to pay taxes on it as if this was business income.
Your record of revenues received should, at the least, record similar information:
- The type and amount of payment.
- Date of the transaction.
- The party who paid the money.
- The work performed or good provided.
Asset Records All equipment (e.g., computers, fax machine, copiers, etc.) and other assets which have a life span of more than a year must be recorded and the cost amortized (i.e., deducted) over the life span of the asset. Thus, you need to keep records concerning your business’s asset. You must keep asset records providing the following information:
- Description of the asset.
- Date of acquisition.
- What month you started using the asset (usually the same as purchase).
- Total amount paid for the item, including taxes, delivery charges and fees.
- Sales price of any asset sold.
- Date of sale of any asset.
- Cost of selling the asset (advertisement, broker’s fees, etc.)
- Whether you use the assets for personal use and, if so, how much time the asset is employed for such uses.
Again, there are excellent computer programs which will help you maintain these records!